Monday, 28 January 2019

How Your Credit Score Works

What exactly is a credit score? In this article, we'll be digging deep into the details. It's important to understand these concepts because, with knowledge like this, you can take the right steps to build or boosting your score and maintaining a high score

How Credit Scores Work

  • Between 300 - 850 (FICO Score)
  • Calculated by the Credit Bureaus
  • Credit History past 2 years, up to 7+ years
  • The formula is made of components

Your credit score is a number between 300 and 850, one thing to note here and this applies for the rest of this article, is that everything I'm discussing in terms of credit score calculations is based on the "FICO Credit Score Model" There are several score models out there but FICO is the standard and by far the most common, it's used by 90% of lenders and by the three credit bureaus, so that's what we'll be reviewing. Your credit score is calculated by the credit bureaus which we'll cover next and it's based on details from your credit history over the past two years and in some cases takes into account events from up to seven years ago or more. The scoring model is essentially a formula made up of different components like payment history and amount owed.

Credit Score Ranges

A credit score can be between 300 and 850 but what's the breakdown within that. What's a good vs a bad score an average vs an excellent score

A credit score can be classified into five different ranges, the top range which means you have excellent credits score between 740 and 850
You will be approved for almost any credit card and you'll be eligible for the lowest financing rated available when looking at loans and mortgages

The good score which is between 700 and 740, you'll still be able to be approved for most credit cards including the really food rewards cards and you should be eligible for the lowest rates on loans. The average score is between 640 and 700 which is the most common range, you probably have one or a few negative marks but nothing crazy like bankruptcy on your report and maybe you just don't have a long credit history. You will have access to a good number of credit cards and should be approved for loans although you most likely won't qualify for the lowest rate. The bad scores, you've got some serious negatives issues with your credit report and the creditors you look pretty risky, you may have trouble getting a approve for loans and credit cards in this range especially if you're in the 500s and if you do get approved, you'll be paying high-interest rates

Any score below 500 is very bad, you'll have trouble borrowing any form and you'll need to do some serious work to improve your score

2. Who is Calculating Them (Credit Bureaus)

  • Credit Reporting Agencies: "CRAs"
Now let's take a look at who's actually tracking your credit information and calculating your scores. Credit bureaus are kind of seen as these opaque official entities, let's break them down a little bit. There are three of them

  1. Equifax
  2. Transunion
  3. Experian

They're also known as CRA credit reporting agencies, if we look at the US government's website definition, we can see that they're really just organizations set up to gather people's credit information and sell it to credits employers and other interested parties

The gathering process works like this. 

  • Creditors (Lenders) report your activity to the CRAs on a monthly basis
  • Reported: Balance outstanding, history of payments, amounts in collections, and other items
  • Different CRA, Different Score
  • Different score formulas
  • Differences in the underlying information

Something that's good to know is that your score can differ between the different credit bureaus. They might be using slightly different score formulas. There also could be differences in the underlying information may be one Bureau has an error within their report or it could just be that a creditor didn't report your information to all the credit bureaus at the same time. At the end of the day though unless there's a big error or item not reported to one agency, your score across all three should be within a relatively close range

Hopefully, you learn something new from this article

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